Attorneys Tamara Pow and Jack Easterbrook recently participated in a panel discussion of San Jose and Silicon Valley commercial real estate owners, lenders, borrowers and other professionals about issues arising in recent commercial real estate transactions. Jack and Tamara, at the conference, presented a “Top 10 List” of things to be alert to in real estate loan documents. It was assumed that the basic business terms of the purchase and sale agreement and loan transaction had been negotiated and agreed upon. The question posed was, “So what pitfalls can occur after that, and what issues do you want to be alert to as the deal gets documented – particularly in connection with the debt financing?” The point being emphasized was that a transaction can move to a closing with a minimum of angst if the parties identify early on those issues that will be important deal points, but may not be covered in detail in the financing terms outlined in a term sheet or commitment letter.
This blog addresses three of the “Top 10” points raised in the presentation. Subsequent blogs will address remaining items discussed at the conference. No one point is necessarily more important than the others, as the relative importance of a particular item will vary transaction to transaction. However, the attorneys at Structure Law Group see these factors repeatedly arising in real estate loan transactions.
No. 1: Inconsistency Between Borrower’s State of Registration and Lender’s Requirement.
Comment: An institutional lender sometimes has very specific requirements. If the owners are establishing a new entity to serve as the borrowing entity, they may want to wait to register the company until after a lender is chosen and any jurisdictional issues are clarified. In some unfortunate situations, we have seen borrowers go ahead with the formation of their entity in California, only to later be asked to provide the lender with a nonconsolidation opinion that may only be viable under the law of another state such as Delaware. So, in addition to asking the lender for any requirements it may have with regards to the type of entity being formed, the jurisdiction, or the bankruptcy remote requirements, make sure to ask what opinions, if any, they will be requesting from counsel. Often these opinions can be negotiated in advance so that you are sure you are forming in a state that is consistent with those requirements.
No. 2: The Special Purpose Entity and Independent Director/Manager Requirements of the Lender.
Comment: In addition to possible Lender requirements regarding which state to form your legal entity in, your lender may have specific requirements that the entity you form to take title to the property is a special purpose entity, meaning that it is formed for the purpose of holding this property only, and will not hold other properties or do other lines of business. This way the lender can feel secure that its collateral will not be negatively affected by any other properties or going concerns in the entity. In addition, the Lender may require that the entity appoint independent directors or managers who will act on its behalf when a vote is required for the entity to declare bankruptcy, or other dangers to its collateral. Sophisticated lenders will have clear language requirements that must be added to the entity’s formation documents. In some instances, we have seen lenders require certain language be added to the Articles of Organization of an LLC, but usually it is required to be in the operating agreement of the LLC. However, again, make sure you and your advisors check with your potential lenders in advance of forming your entity, otherwise you may have the additional expense of amending and restating your organizational documents.
No. 3: The Personal Guaranty: Details of Its Scope.
Comment: Several different kinds of guarantees are in use beyond the full guaranty often preferred by lenders. Examples of these are the partial guaranty exempting assets or obligations, the “Bad Boy” guaranty, and the springing guaranty. A recent court case, known as Series AGI West Lynn, held that carve outs or limitations in guaranties will be very strictly construed. A carve out prohibiting the lender from taking any action against the guarantor’s house, the court found, did not include proceeds from the sale of the house even though the funds were placed in segregated accounts. In a victory for the lender, the court noted that although the house was excluded under the guaranty, it did not expressly provide that proceeds from a sale of the house were excluded. The court noted that it was not its job to protect the parties from the ugly implications of the plain language in their negotiated agreements.
The remaining items addressed at the conference will be the subject of a later blog, coming in early 2014!
The information appearing in this article does not constitute legal advice or opinion. Such advice and opinion are provided by the firm only upon engagement with respect to specific factual situations. Specific questions relating to this article should be addressed directly to the author.